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Similar to option theory’s concept of time decay, the concept draws on the idea that “time is the enemy”. Thus, unless a security can continue to generate more profits over time, it should be liquidated. The indicator generally works only in trending markets, and creates “whipsaws” during ranging or, sideways phases. A parabola below the price is generally bullish, while a parabola above is generally bearish. A parabola below the price may be used as support, whereas a parabola above the price may represent resistance. The parabolic SAR is calculated almost independently for each trend in the price.
When the price is in an uptrend, the SAR emerges below the price and converges upwards towards it. Similarly, on a downtrend, the SAR emerges above the price and converges downwards. At each step within a trend, the SAR is calculated one period in advance. That is, tomorrow’s SAR value is built using data available today. 1 represent the current period and the next period’s SAR values, respectively. EP is updated with that value. The α value represents the acceleration factor.